Financing a Second Home and an Investment Property Differ

Financing a Second Home and an Investment Property Differ

Financing a Second Home and an Investment Property TipsWhile digging toes in the sand or swishing skis through powdery snow, we often imagine what it would be like to own our little slice of vacation heaven. With historically low interest rates, the idea of taking out a mortgage for a home away from home may seem a bit more possible, especially if you can earn income through rental. However, mortgage programs, interest rates, credit requirements, underwriting restrictions and tax implications vary depending on how you plan to utilize the home.

So it’s important to understand what defines a second home versus an investment property. By definition, a second home is a residence located in a desirable area such as the beach or mountains that you intend to occupy for part of the year. By IRS guidelines, this is more than 14-days or roughly 10 percent of the year. An investment property is also a home in a desirable area but one that you do not intend to occupy. It is purchased with the sole intent of providing rental income.

Each option has benefits and disadvantages, especially in the eyes of your lender and Uncle Sam. Both second homes and investment properties are considered residences, so mortgage interest and property taxes are deductible. However, financing is vastly different depending on the intended usage. A conventional loan for a second home requires a 10 percent down payment and will carry a slightly higher interest rate than a primary mortgage. However, investment property mortgages are viewed as a greater risk due to loan repayment from rental income, so expect a higher interest rate as well as an increased down payment requirement – often around 25 percent.

Investment properties can provide ongoing income to offset the expenses and may provide certain tax benefits. When you rent your property, this money must be reported as income on your taxes. However, you may be able to deduct rental expenses such as utilities, taxes, repairs and wages for employees working at or on your property, reducing your tax obligations. Additionally, there are tax breaks for property depreciation, which is the gradual wear and tear of the home over a period of time. A knowledgeable tax advisor can review depreciation guidelines for your particular property before purchase.

While it’s easy to focus on the many perks of owning a vacation home, you must consider the drawbacks as well.

Cost

The costs of a second home can be considerably more than your primary residence. Many second home buyers make the mistake of taking on too much financial responsibility without proper planning and end up having to sell more quickly than is optimal.

Distance

The further the home is from your primary residence, the greater the need to rely on outside assistance for managing upkeep and repair. Many rental properties use local management companies to handle bookings, payments, cleaning and emergency repairs, and there are of course fees associated with these services.

Location Location Location

Your experience of a vacation spot is most often from the perspective of a visitor, so researching the area as a potential resident is vital. Evaluating property values and recent home sales as well as taxes, association fees (if applicable) and insurance requirements are all helpful in determining what you can comfortably afford.

Renting

With the purchase of an investment property, you’re not only assessing property values but also the fair market rates for rentals in the area. Knowing how much you will be able to charge for rent as well as the duration of peak season in that particular location will help determine how much yearly rental income you can expect. For instance, a beach home that sees heavy bookings from April through September must net enough income to offset the months of off-season rates. Speaking to local homeowners is an excellent way to gain real insider information on the area and what to expect during busy/slow times.

 

Before making any decisions, review all available financing options with a mortgage lender. And a trusted, experienced local Realtor is an invaluable resource of information on the area’s housing market and available properties to fit your specific needs. There are risks as well as rewards with any purchase of a vacation home and educating yourself prior to a purchase can help prevent future headaches and heartaches.

 

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